June 14, 2012

Tier 3 Regulations

June 14, 2012

Although the general public hasn’t heard much about it, the EPA is preparing to issue so-called “Tier 3” regulations on automakers and refiners, which are even more stringent than the “Tier 2” standards announced in 1999 and fully implemented in 2006. As usual, EPA hasn’t given a satisfactory justification for the tightening of the standards. One study conservatively estimates Tier 3 would impose an upfront compliance cost on refiners of almost $10 billion, and would permanently raise refinery costs 6 to 9 cents per gallon.

Background

In addition to the numerous other regulations affecting the transportation and energy industries, the Environmental Protection Agency (EPA) issues regulations governing tailpipe emissions from qualifying vehicles. In 1999 EPA announced its so-called Tier 2 regulatory framework, which tightened emission standards for the first time not just to cars but to all passenger vehicles, including light-duty trucks and SUVs. The other innovation introduced in 1999 was to treat “vehicles and fuels as a system.” Because certain emission-reduction technologies work better with lower sulfur content in gasoline, the Tier 2 standards—which were ostensibly concerned with passenger vehicles—also placed costly mandates on refiners.

The EPA is currently moving ahead with its plans to implement the next level of controls, called Tier 3. Even though Tier 2 has already achieved significant improvements in several dimensions, EPA wants to significantly tighten the constraints on both the passenger vehicle and refining sectors once again. The best available study suggests that just a single component of the new Tier 3 proposal would impose upfront compliance costs of almost $10 billion on refiners, and cause a permanent increase in refining costs of 6 to 9 cents per gallon of gasoline. Although the effects have not been estimated, we can also expect the Tier 3 standards to raise vehicle costs.

Worst of all, the increased costs that Tier 3 would impose on vehicle manufacturers and refiners would come with little if any added benefit to the environment. Under the existing Tier 2 standards, the EPA has already achieved significant gains across several criteria, with further progress becoming exponentially more difficult. EPA’s own statements indicate that with existing regulations, these improvements would continue for years into the future, as new cars (compliant with Tier 2) replaced older vehicles on the road.

Tier 2 Was Tight; Tier 3 Would Be Even Tighter

In 1999 EPA issued its Tier 2 regulatory framework, and proudly announced how drastic the measures were: “These new standards require passenger vehicles to be 77 to 95 percent cleaner than those on the road today and reduce the sulfur content of gasoline by up to 90 percent.” Specifically, here is their discussion of the sharp reduction in permissible sulfur concentrations:

Beginning in 2004, the nation’s refiners and importers of gasoline will have the flexibility to manufacture gasoline with a range of sulfur levels as long as all of their production is capped at 300 parts per million (ppm) and their annual corporate average sulfur levels are 120 ppm. In 2005, the refinery average will be set at 30 ppm, with a corporate average of 90 ppm and a cap of 300 ppm….Finally, in 2006, refiners will meet a 30 ppm average sulfur level with a maximum cap of 80 ppm.

Yet even though the Tier 2 standard has already reduced gasoline sulfur content some 90 percent, down to an average level of 30 parts per million (ppm), EPA wants to ratchet up the standard yet again. Although it hasn’t explicitly announced the specific standard in its Tier 3 regulations as of this writing, EPA officials (e.g. Margo Oge in late January 2012) have publicly stated that the standard will probably be 10 ppm. That is to say, on top of the 90 percent reduction in sulfur content that Tier 2 involved, the move to Tier 3 (if Oge is correct in her statement) would require a further reduction of 67 percent from the Tier 2 baseline.

The Baker & O’Brien Analysis

The American Petroleum Institute (API) commissioned Baker & O’Brien to perform a study that was originally released in July 2011 on the impact of Tier 3 regulations on the refining sector and gasoline market. In light of criticism from EPA—claiming that the original study should not have included a scenario considering a 5 ppm standard, but instead a looser 10 ppm standard—API commissioned Baker & O’Brien to issue a March 2012 addendum. In this addendum, the analysts consider a “Case 4” that keeps all other regulations constant, and only changes the gasoline sulfur content from the current 30 ppm down to 10 ppm. To be clear, the March 2012 analysis is very conservative and is based on the bare minimum of what EPA has suggested it will impose in Tier 3 standards.

The Baker & O’Brien revised Case 4 scenario—which models only the tightening of gasoline sulfur standards, in light of the recent remarks from EPA officials—projects the upfront compliance costs to refiners at $9.8 billion. Furthermore, the total annual compliance cost (which includes capital recovery) is estimated at $2.4 billion. Spread out over the range of projected gasoline production, this higher operating cost works out to 6 to 9 cents per gallon in increased costs.

Gains Would Continue Under Existing Tier 2 Regulations

These conservative estimates of the cost impact of tighter Tier 3 regulations are more troublesome when we realize that the existing Tier 2 standards have yielded significant improvements according to the EPA’s own goals, and would continue to do so even without tightening the standards.

On March 19, 2012, Charlie Drevna, president of the trade group American Fuel and Petrochemical Manufacturers (AFPM), testified before Congress on the reasons for U.S. refinery closures. Drevna’s testimony specifically mentions the progress that has been made under the existing regulatory framework:

Refiners have cut sulfur levels in gasoline by 90 percent just since 2004. We have also reduced sulfur in diesel fuel by more than 90 percent since 2005 and reduced benzene in conventional gasoline by 45 percent since 2010.

EPA data shows that total emissions of the six principal air pollutants in the United States have dropped by 57 percent since 1980 and ozone levels have decreased by 30 percent. These reductions occurred even as industrial output and the number of vehicles on the road have increased. EPA data indicates there will be continued reductions in the years ahead under regulations already in place.

Conclusion

Even in a prosperous economy, tightening the screws even more on the vehicle and refining sectors—while achieving little if any incremental environmental benefits—would be a dubious proposition. To do so, as EPA intends, in the midst of a severe recession with high gasoline prices is particularly reckless.